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Question
IntegrativeCase2TrackSoftware,Inc.

Sevenyearsago,after15yearsinpublicaccounting,StanleyBooker,CPA,resignedhispositionasmanagerofcostsystemsforDavis,Cohen,and
OBrienPublicAccountantsandstartedTrackSoftware,Inc.Inthe2yearsprecedinghisdeparturefromDavis,Cohen,andOBrien,Stanleyhadspent
nightsandweekendsdevelopingasophisticatedcostaccountingsoftwareprogramthatbecameTracksinitialproductoffering.Asthefirmgrew,Stanley
plannedtodevelopandexpandthesoftwareproductofferings,allofwhichwouldberelatedtostreamliningtheaccountingprocessesofmediumtolarge
sizedmanufacturers.

AlthoughTrackexperiencedlossesduringitsfirst2yearsofoperation2009and2010itsprofithasincreasedsteadilyfrom2011tothepresent(2015).
Thefirmsprofithistory,includingdividendpaymentsandcontributionstoretainedearnings,issummarizedinTable1.

Stanleystartedthefirmwitha$100,000investment:hissavingsof$50,000asequityanda$50,000longtermloanfromthebank.Hehadhopedto
maintainhisinitial100percentownershipinthecorporation,butafterexperiencinga$50,000lossduringthefirstyearofoperation(2009),hesold60
percentofthestocktoagroupofinvestorstoobtainneededfunds.Sincethen,nootherstocktransactionshavetakenplace.Althoughheownsonly40
percentofthefirm,Stanleyactivelymanagesallaspectsofitsactivitiestheotherstockholdersarenotactiveinmanagementofthefirm.Thefirms
stockwasvaluedat$4.50persharein2014andat$5.28persharein2015.

TABLE1
TrackSoftware,Inc.,
Profit,Dividends,andRetainedEarnings,20092015
Netprofits

Dividends

Contributionto

after
taxes

paid

retainedearnings

Year

(1)

(2)

[(1)(2)]=(3)

2009

($50,000)

$0

($50,000)

2010

(20,000)

(20,000)

2011

15,000

15,000

2012

35,000

35,000

2013

40,000

1,000

39,000

2014

43,000

3,000

40,000

2015

48,000

5,000

43,000

Stanleyhasjustpreparedthefirms2015incomestatement,balancesheet,andstatementofretainedearnings,showninTables2,3,and4,alongwith
the2014balancesheet.Inaddition,hehascompiledthe2014ratiovaluesandindustryaverageratiovaluesfor2015,whichareapplicabletoboth2014and
2015andaresummarizedinTable5.Heisquitepleasedtohaveachievedrecordearningsof$48,000in2015,butheisconcernedaboutthefirmscash
flows.Specifically,heisfindingitmoreandmoredifficulttopaythefirmsbillsinatimelymannerandgeneratecashflowstoinvestors,bothcreditors
andowners.Togaininsightintothesecashflowproblems,Stanleyisplanningtodeterminethefirms2015operatingcashflow(OCF)andfreecashflow
(FCF).

Stanleyisfurtherfrustratedbythefirmsinabilitytoaffordtohireasoftwaredevelopertocompletedevelopmentofacostestimationpackagethatis
believedtohaveblockbustersalespotential.Stanleybegandevelopmentofthispackage2yearsago,butthefirmsgrowingcomplexityhasforced
himtodevotemoreofhistimetoadministrativeduties,therebyhaltingthedevelopmentofthisproduct.

Stanleysreluctancetofillthispositionstemsfromhisconcernthattheadded$80,000peryearinsalaryandbenefitsforthepositionwouldcertainlylower
thefirmsearningspershare(EPS)overthenextcoupleofyears.Althoughtheprojectssuccessisinnowayguaranteed,Stanleybelievesthatifthe
moneywerespenttohirethesoftwaredeveloper,thefirmssalesandearningswouldsignificantlyriseoncethe2to3yeardevelopment,production,and
marketingprocesswascompleted.

Withalltheseconcernsinmind,StanleysetouttoreviewthevariousdatatodevelopstrategiesthatwouldhelpensureabrightfutureforTrackSoftware.
Stanleybelievedthataspartofthisprocess,athoroughratioanalysisofthefirms2015resultswouldprovideimportantadditionalinsights.

TABLE2
TrackSoftware,Inc.,IncomeStatement($000)
fortheYearEndedDecember31,2015
Salesrevenue

$1,550

Less:Costofgoods
sold

$1,030

Grossprofits

$520

Less:Operatingexpenses
Sellingexpense

$150

Generalandadministrativeexpenses

270

Depreciationexpense

11

Totaloperatingexpense

431

Operatingprofits(EBIT)

$89

Less:Interestexpense

29

Netprofitsbeforetaxes

$60

Less:Taxes(20%)

12

Netprofitsaftertaxes

$48

TABLE3
TrackSoftware,Inc.,BalanceSheet($000)
December31
Assets

2015

2014

Cash

$12

$31

Marketablesecurities

66

82

Accountsreceivable

152

104

Inventories

191

145

Totalcurrentassets

$421

$362

Grossfixedassets

$195

$180

Less:Accumulateddepreciation

63

52

Netfixedassets

$132

$128

Totalassets

$553

$490

Accountspayable

$136

$126

Notespayable

200

190

Accruals

27

25

Totalcurrentliabilities

$363

$341

Longtermdebt

$38

$40

Liabilitiesandstockholdersequity

Longtermdebt

$38

$40

Totalliabilities

$401

$381

at$0.40parvalue)

$20

$20

Paidincapitalinexcessofpar

30

30

Retainedearnings

102

59

Totalstockholdersequity

$152

$109

Totalliabilitiesandstockholdersequity

$553

$490

Commonstock(50,000sharesoutstanding

TABLE4

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TrackSoftware,Inc.,
StatementofRetainedEarnings($000)
fortheYearEndedDecember31,2015
Retainedearningsbalance(January1,2015)

$59

Plus:Netprofitsaftertaxes(for2015)

48

Less:Cashdividendsoncommonstock(paidduring2015)

Retainedearningsbalance(December31,2015)

$102

TABLE5
Industrial
Actual

Average

Ratio

2014

2015

Currentratio

1.06

1.82

Quickratio

0.63

1.1

Inventoryturnover

10.4

12.45

Averagecollectionperiod(days)

29.6

20.2

Totalassetturnover

2.66

3.92

Debtratio

0.78

0.55

Timesinterestearnedratio

5.6

Grossprofitmargin

32.1%

42.3%

Operatingprofitmargin

5.5%

12.4%

Netprofitmargin

3.0%

4.0%

Returnontotalassets(ROA)

8.0%

15.6%

Returnoncommonequity(ROE)

36.4%

34.7%

Price/earnings(P/E)ratio

5.2

7.1

Market/book(M/B)ratio

2.1

2.2

TODO

a.(1)OnwhatfinancialgoaldoesStanleyseemtobefocusing?

Isitthecorrectgoal?Whyorwhynot?

(2)Couldapotentialagencyproblemexistinthisfirm?
Explain.

b.Calculatethefirmsearningspershare(EPS)foreachyear,
recognizingthatthenumberofsharesofcommonstockoutstanding
hasremainedunchangedsincethefirmsinception.

CommentontheEPSperformanceinviewofyourresponseinparta.

c.UsethefinancialdatapresentedtodetermineTracksoperatingcashflow(OCF)
andfreecashflow(FCF)in2015.

EvaluateyourfindingsinlightofTrackscurrentcashflowdifficulties.

Answer

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